Chapter 8

Corporate trustees and insolvent trusts

Issues for creditors

P34 There should be an amendment to the Companies Act 1993 to provide for the liability of directors of companies acting as trustees for trust liabilities, based on section 197 of the Corporations Act 2001 (Cth), which provides:

Directors liable for debts and other obligations incurred by corporation as trustee

(1) A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or a part of the liability if the corporation:

(a) has not discharged, and cannot discharge, the liability or that part of it; and(b) is not entitled to be fully indemnified against the liability out of trust assets solely because of one or more of the following:

(i) a breach of trust by the corporation;(ii) the corporation's acting outside the scope of its powers as trustee;(iii) a term of the trust denying, or limiting, the corporation's right to be indemnified against the liability.

The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection. Note: The person will not be liable under this subsection merely because there are insufficient trust assets out of which the corporation can be indemnified.(2) The person is not liable under subsection (1) if the person would be entitled to have been fully indemnified by one of the other directors against the liability had all the directors of the corporation been trustees when the liability was incurred.

P35 New trusts legislation should provide for a mechanism for the appointment of a liquidator/receiver of a trust, who could manage or liquidate the trust fund. This would apply generally, not only to trusts with corporate trustees.

Please give us your views on these proposals.

Current law

8.47Under the current law, existing trust and company law obligations apply to corporate trustees and their directors. This approach places the risks of dealing with an assetless corporate trustee mainly with the third party looking to contract with it, although the corporate trustee and its directors would still be bound by duties under the Companies Act and the Fair Trading Act 1986. Creditors have their primary claim against the trustee personally, and rely on the trustee’s right of indemnity to recover their debts if the trustee has insufficient assets. Creditors bear the risk that the indemnity is not available, possibly leaving them with no recourse to have their debt satisfied. It is potentially open to settlors to exclude the right to indemnity via the trust deed and trustees to accept the position with this limitation (although it is as yet unclear in New Zealand whether such a provision would undermine the existence of the trust).

8.48The current position puts the onus on the creditor to protect their position, either by taking security if they are able to do so, or by establishing for themselves the extent of the trustee’s indemnity, whether it is limited or excluded by the terms of the trust, and whether the trustee is acting within its capacity and authority in entering into the contract. Smaller and/or less sophisticated creditors may be constrained in their ability to obtain such protections, due to lack of awareness about the need for them or limited negotiating power.

Issues

8.49The key problem in this area is that, as in Levin v Ikiua,196 creditors of a corporate trustee may be left without redress. This may occur where the directors distribute the trust funds regularly so that the trustee holds few or no assets, and the beneficiaries, who receive the funds, alter their position in reliance on the validity of such distributions. Several submitters referred to this problem in their comments.

8.50There is also a potential problem for creditors if, for any of a number of reasons,197 the trustee loses its right to indemnity, and consequently the creditor cannot recover through subrogation. It seems unfair or inappropriate that a creditor acting in good faith can be left out of pocket due to the unrelated acts of a trustee, and this can result in a windfall for the beneficiaries of the trust, as noted in the Fifth Issues Paper and by some submitters. A more serious aspect of this would be corporate trustees incurring liabilities with no intention of meeting those obligations, perhaps in reliance on creditors being unable to have recourse to the trust assets, whether directly or indirectly.

8.51There is a question over whether this is an issue exclusive to “trading trusts” or companies acting as trustees. Several submitters hold the view that it is not a special problem in dealing with trading trusts, but merely the same type of common problem faced by creditors dealing with companies and other third parties generally (such as solvency, effective contractual enforcement, and debt recovery). The NZLS considered that although a creditor’s right of recourse against a trading trust with a corporate trustee was more difficult than, say, a company, actual problems of this nature do not really arise in practice, in light of helpful judicial authorities and creditors’ willingness to seek recourse from directors.

Options for reform

8.52Two of the options considered in the Fifth Issues Paper are discussed above: disclosure of trustee status (option 1) and preventing exclusion of the trustee’s right to indemnity (option 2). The remaining options, set out in more detail in chapter 7 of the Fifth Issues Paper, are:198

Option 3: Strengthening the creditor’s access to the right to indemnity, for instance providing that the creditor can still rely on indemnity from the trust fund irrespective of whether the trustee acted in breach of trust in incurring the liability or was otherwise indebted to the trust fund.

Option 4: Giving trustees the power to grant charges for creditors over trust assets.

Option 5: Providing creditors with direct recourse to trust assets in some situations, without needing to rely on the trustee’s right of indemnity.

Option 6: Providing for liability of directors of companies acting as trustees for trust liabilities in some situations, based on section 197 of the Corporations Act 2001 (Cth).

Option 7: Retaining the status quo, so that existing trust and company law obligations would continue to apply to corporate trustees and their directors.

8.53In addition, in submissions to the Fifth Issues Paper the NZLS and the Inland Revenue have both proposed the introduction of the ability to appoint a liquidator/receiver of a trust (referred to below as Option 8).

Discussion

8.54There was not a clear consensus among submitters in respect of the options proposed in the Fifth Issues Paper. There was a measure of support for retaining the status quo, with a number of submitters saying that there is not enough evidence of a defined problem to intervene in this area (a position which may be strengthened in light of the preferred approaches involving disclosure requirements and addressing the exclusion of indemnity).

8.55However, marginally more submitters favoured some kind of reform than supported retaining the status quo, even if there were differences of opinion as to the appropriate approach to be taken. We have considered the various possible options for reform. We have come to the view that, of the options considered, there are two key proposals that should be carried forward:

Option 6: providing for liability of directors of companies acting as trustees for trust liabilities in certain circumstances; and

Option 8: providing a mechanism for a liquidator/receiver of a trust (not included in the Fifth Issues Paper).

8.56Option 6 (liability of directors of companies acting as trustees) was supported by a number of submitters. Chapman Tripp and KPMG both noted the existing laws that impose obligations on directors of companies. KPMG considered that due to existing obligations already on directors there is no real difficulty in this area, but section 197 would be acceptable if clarity were required; KPMG thought any rule changes should apply to all trusts and trustees.

8.57Option 8 (the ability to appoint a liquidator/receiver) was not traversed in the Fifth Issues Paper in relation to this issue. However, the NZLS and the Inland Revenue have both indicated that they would favour a clear procedure to be able to liquidate a trust using an independent liquidator/administrator. The Inland Revenue was concerned that there is no legislative mechanism enabling a creditor to have a trust “wound up” or terminated if it is not paying its debts or is insolvent. In a submission to the Second Issues Paper199 the MED stated that it would favour a cost-effective mechanism for creditors to recover trust debts from trustees without having to file for bankruptcy or have the trustee replaced, such as having the Public Trustee or Official Assignee appointed as administrator or receiver.

8.58Submitters’ comments on the other options are set out below.

8.59Option 3: Strengthening creditors’ access to the right to indemnity: This option was supported in one form or another by a number of submitters. KPMG noted that ultra vires defence to a transaction under company law has effectively been removed, so trusts should not be treated any differently; Chapman Tripp considered that it should remain up to the creditor to address the risk of the trustee’s power and capacity to enter into the contract (no indoor management-type rule) but did support the approach that when a trustee who is indebted to the trust for reasons unconnected with a contract with a particular creditor, that indebtedness should not prevent the creditor from being indemnified out of the trust fund, although it would reduce the right of indemnity to the extent of the indebtedness. Greg Kelly Law, the TCA and Perpetual thought that creditors’ rights should not be affected by breach of the terms of the trust of which the creditor was not aware or did not appreciate the significance. Jeff Kenny made a particular proposal related to this option, of modernising and expanding section 22 of the Trustee Act to protect persons, such as secured and unsecured creditors, dealing with trustees in good faith for proper value.

8.60Option 4: Giving trustees the power to grant charges for creditors over trust assets: This option was not generally favoured by submitters. Chapman Tripp in particular argued that there was no justification for new legislation in this area; most modern trust deeds contain such a power in any case. However KPMG thought that to protect unsuspecting creditors who have obtained void security, it should be a rebuttable presumption that the security is valid unless the creditor knew the trustee was acting outside their powers.

8.61Option 5: Providing creditors with direct recourse to trust assets: This was the preferred option of some submitters, and was also supported by others. The MSD wanted to give access to creditors and any other parties (such as spouses, government agencies) when they have suffered a loss caused by the trust or associated entity, or where there is a debt owing. The Inland Revenue noted that the risk of having a misbehaving trustee should fall on the beneficiary/trust estate and not on a creditor, particularly an involuntary creditor; this reform would be an incentive to appoint directors or trustees of straw. Greg Kelly Law thought there was some merit in direct access but not the complete reversal of our present law suggested in paragraphs [7.54] to [7.58] of the Fifth Issues Paper. This option was supported by Taylor Grant Tesiram, but as a default position, one capable of being modified through contract. If a creditor misses out on direct recourse because for example the trustee has distributed all of the trust assets, the creditor may still pursue remedies against the trustee personally. Taylor Grant Tesiram noted a number of exceptions to permitting creditors to have direct access to trust assets that would be required. This option was expressly not supported by Chapman Tripp.

8.62Option 7: Retaining the status quo: the NZLS preferred to maintain the status quo, saying the difficulties faced by creditors caused by trading trusts are not sufficiently serious, widespread or identifiable to warrant legislative or other intervention. Chapman Tripp and the TCA also considered there are already methods of preventing or remedying the problem (such as seeking undertakings from the trustee that it will not distribute to beneficiaries if it reduces the trust assets to below a certain level, akin to a reserve fund; seeking indemnities or guarantees from key beneficiaries; contracting on the basis that liability is limited to the assets of the trust; seeking a floating charge; sections 344 to 350 of the Property Law Act 2007; sections 135 and 136 of the Companies Act). KPMG said there was arguably no need for reform, but if the law is being redrafted anyway, it would be appropriate to include stronger remedies for creditors, if only for deterrent effect, due to the impact of financial exposure on businesses and the fact that it can be costly to take steps such as obtaining security, investigating the indemnity and so on.

Providing for liability of directors

8.63Our preferred approach is for an amendment to the Companies Act based on an adaptation of the Australian section 197 of the Corporations Act 2001 (Cth) to ensure that directors of corporate trustees are liable to discharge a liability incurred by the company acting in its capacity as trustee. Section 197 provides:

Directors liable for debts and other obligations incurred by corporation as trustee

(1) A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or a part of the liability if the corporation:

(a) has not discharged, and cannot discharge, the liability or that part of it; and(b) is not entitled to be fully indemnified against the liability out of trust assets solely because of one or more of the following:

(i) a breach of trust by the corporation;(ii) the corporation's acting outside the scope of its powers as trustee;(iii) a term of the trust denying, or limiting, the corporation's right to be indemnified against the liability.

The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection. Note: The person will not be liable under this subsection merely because there are insufficient trust assets out of which the corporation can be indemnified.(2) The person is not liable under subsection (1) if the person would be entitled to have been fully indemnified by 1 of the other directors against the liability had all the directors of the corporation been trustees when the liability was incurred. …

8.64In the Fifth Issues Paper we discussed this provision and noted that its basis for introduction was that it is reasonable to encourage all directors of companies acting as trustees to ensure that the company does not enter into trust deeds which deny creditors access to trust assets to meet liabilities incurred by the company. Its purpose was to ameliorate the consequences for creditors where there is no access to trust funds to meet liabilities incurred by a corporate trustee.200

8.65We consider that it would be worthwhile to introduce such a provision, even though we are proposing elsewhere not to permit exclusion or limitation of the trustee’s right to indemnity in the trust deed. It would give creditors an avenue of protection in the event of a breach of trust or ultra vires conduct by the trustee. It would also be useful for our law to align with that of Australia in this area, where this provision has been in operation for several decades. Further, while this option still requires steps to be taken to enforce a claim against the directors, it is hoped it would deter directors from allowing a situation to arise where the company is unable to meet its liability and is not entitled to be indemnified from the trust assets.

8.66We acknowledge that such a proposal would not provide a full guarantee for repayment of creditors, as it would depend on the available asset base of the directors. We also recognise the potential for such a proposal to discourage persons from acting as directors of trustees, due to expanded personal liability and the possible effect on indemnity insurance; however we do not consider that directors will be significantly discouraged.

8.67In drafting a version of this provision for New Zealand the following points will require further consideration:

(a)whether to list the circumstances of extinguishment or limitation of the right of indemnity, as section 197 does in subsection (1)(b)(i) to (iii), define these circumstances more widely or narrowly, or to leave this aspect open to be determined by the courts – our preliminary view is that this should either be left open or should at least contain a general catch-all provision;(b)whether any protections or defences to liability under the provision should be available to directors under the section, or a discretion so that the court can only impose liability if it is just and equitable to do so; and(c)how to address the issue of directors ensuring that the trust has insufficient funds to fulfil the right of indemnity, for example by requiring the directors to discharge all company debts and out of pocket expenses before proceeding to distribute the balance of trust funds to the beneficiaries, and whether this situation should be brought within the ambit of the section.

8.68We are interested in submitters’ views about how this provision would operate in practice.

Providing for the appointment of a trust liquidator/receiver

8.69As outlined above, this was an option raised in discussion with the NZLS201 and was supported by the Inland Revenue. We consider this has the potential to be a very useful process; the receiver can take charge of the fund, deal with and if necessary realise some assets, conduct a managed distribution, and if appropriate, hand back the fund to the trustees.

8.70We note that in law there is already the ability for the court to appoint a receiver in respect of trust property under its inherent jurisdiction, so this is not a new process; while receivers are more commonly thought of in connection with companies, the jurisdiction of the court to appoint one is not limited to companies.202 An example of the exercise of the jurisdiction in respect of trusts in New Zealand is the case of Molloy v Molloy.203 It has also been employed overseas.204 However, it appears this jurisdiction is rarely used; this may in part stem from a lack of awareness or understanding that this option is available. In addition, at the moment there is no mechanism to liquidate a trust (aside from winding up). And although it is possible to liquidate a company acting as a trustee, there is nothing to prevent serial appointments of new trustees, which would in turn require new proceedings to liquidate.

8.71We consider that it would be beneficial, therefore, to clarify in trusts legislation that the court can appoint a receiver to deal with a trust and the trust fund, and to provide that a liquidator is also an option. However, we would emphasise that this proposal should not be taken as limiting the existing receivership jurisdiction of the court in any way. It should also be noted that we consider this proposal should apply not only to trusts that have corporate trustees, but to trusts more broadly, as is the position in equity at present.

8.72Certain features of the process would need to be determined and set out in legislation, such as:

(a)who is able to make an application for the appointment of a receiver/liquidator (the NZLS favoured the process being available at the behest of a creditor, but this could be open to other parties as well);(b)the test for when it is necessary for there to be such an appointment (the NZLS proposed the grounds for appointing a liquidator/receiver could be on the basis that it was just and equitable to do so; this would be at the discretion of the court);(c)whether this proposal would apply to all trusts or only to trusts with corporate trustees − as indicated above, at this point we consider that there is not a reason to confine the proposal only to trusts with corporate trustees;(d)where such applications would be heard − we anticipate that this process would have to take place in the same place as company liquidations, namely the High Court;(e)whether to spell out some of the powers of the receiver or liquidator, which would need to be flexible, and would not limit the existing receivership jurisdiction. The powers listed could include realising assets or terminating a trust under the supervision of a court;(f)priorities of those involved − otherwise the question of priorities could be left to be determined under general principles or set out separately in company/insolvency legislation; and(g)payment of fees of the liquidator/receiver: clarification is needed as to whether these fees can be claimed from the trust assets − we consider that it is appropriate that this be the case in these circumstances.